l esson 17 inflation · inflation lesson 17 13. have students read “working with the cpi” in...

LESSON 17

Inflation

BK-CEE-ECONOMICS-131302.indb 239 13-06-2014 03:25:08

HIGH SCHOOL ECONOMICS 3rd EDITION © COUNCIL FOR ECONOMIC EDUCATION, NEW YORK, NY240

LESSON 17

Inflation

LESSON DESCRIPTIONThis lesson introduces students to the

concept of inflation by first discussing purchas-ing power and examining historical prices for several common goods. Students then define inflation and calculate inflation rates using the Bureau of Labor Statistics Consumer Price Index (CPI). Students then examine data on the CPI over time. Finally, students explore who are the “winners” and “losers” when unan-ticipated inflation occurs.

INTRODUCTIONPerhaps your grandparents have told you

stories about paying 20 cents for a gallon of gas. Clearly, the price of gasoline is much higher (about $4 per gallon) today. Many other things—in fact, most things—are like that: The prices of nearly all goods and services increase over time as a result of inflation. Inflation is a long-term increase in the average price level in the economy and is measured by the infla-tion rate or the percentage change in average prices over a fixed period of time (typically a quarter or a year). This change is commonly measured using a price index known as the U.S. Consumer Price Index (CPI). The CPI is calculated using a survey conducted by the Bureau of Labor Statistics that collects infor-mation about the retail prices for a “basket” of goods that they commonly purchase. The CPI reflects the changes in the price of this “market basket” at any one point in time to some other point in time.

Inflation is one of two key macroeconomic problems (along with unemployment) that affect a nation’s economic health. Because of this, keeping inflation in check in the U.S. economy is a goal of the Federal Reserve Bank (the Fed). Inflation’s significant nega-tive consequences on the economy include a

loss in real purchasing power. For example, if all prices rise over time, it takes more money to buy the same amount of goods and ser-vices. A good example is the price of a first-class postage stamp: In 1970, the price was eight cents; in 2013, the price for exactly the same service was 46 cents—nearly six times the 1970 price. Because inflation erodes real purchasing power, it can also erode our standard of living. If it now takes more dol-lars to buy the same goods and services that we bought in 1970, for instance, our income must have also risen at the same rate, or we will be worse off. Inflation such as in this example is often anticipated, as prices tend to rise over time.

Unanticipated inflation, however, is more concerning because it creates uncertainty, and consumers and firms prefer predictability. When inflation is unanticipated, individuals do not realize that they should protect their real purchasing power against inflation until the inflation has already occurred and their purchasing power has already fallen. Unan-ticipated inflation, therefore, creates winners and losers in terms of purchasing power—some consumers and companies benefit while others are harmed.

COMPELLING QUESTIONWhy do some people benefit from inflation, while others are harmed by it?

CONCEPTSInflation

U.S. Consumer Price Index (CPI)

Inflation rate

Purchasing power

Real versus nominal price


HIGH SCHOOL ECONOMICS 3rd EDITION © COUNCIL FOR ECONOMIC EDUCATION, NEW YORK, NY 241

INFLATION LESSON 17

OBJECTIVESStudents will be able to:

Define inflation, inflation rate, and consumer price index (CPI).Explain how inflation affects purchasing power.Determine the price of goods and services from one year to another as adjusted for inflation by using an online calculator.Determine who is harmed or helped by unexpected inflation.

CONTENT STANDARDS

Voluntary National Content Standards in Economics

Standard 19: Unemployment imposes costs on individuals and nations. Unexpected inflation imposes costs on many people and benefits some others because it arbitrarily redistributes purchasing power. Inflation can reduce the rate of growth of national living standards because individuals and organizations use resources to protect themselves against the uncertainty of future prices.

Common Core State Standards

CCSS.ELA-Literacy.RH.11-12.5: Analyze in detail how a complex primary source is structured, including how key sentences, paragraphs, and larger portions of the text contribute to the whole.

TIME REQUIRED45–60 minutes

MATERIALSSlides 17.1–17.20Activities 17.1–17.3, one copy per studentActivity 17.4, one set per group, cut up

PROCEDURES1. Ask students if they have heard their

parents or grandparents complaining about the prices of things today.

Yes, probably about prices for items such as gasoline, the movies, food, etc.

Ask students to share some examples. Show Slide 17.1. Tell students you want to compare historical prices for two goods: a movie ticket and a McDonald’s Big Mac®.

2. Show Slide 17.2 and ask students to guess what the price of a movie ticket was in 1967 and 2012.

2012 = $1.22, 1967 = $7.921

Ask: What did you notice about movie tickets?

The price increased considerably.

Repeat with the data on Big Mac® prices.

2012 = $4.33, 1967 = $0.45 2

3. Distribute Activity 17.1. Show Slide 17.3 and review the formula for calculating percent change. You may practice work-ing through a problem with students before assigning Table 17.1-A. Ask students to complete Table 17.1-A in Activity 17.1. Ask students to calculate the percentage increase in the price of movie tickets from 1967 to 2012.

Percent increase = {[P(year 2) – P(year 1)]/ P(year 1)} × 100 = 549%.

1 Data from National Association of Theater Owners, http://www.natoonline.org/statisticstickets.htm, downloaded July 15, 2013.2 Data from http://www.mcdepk.com/bigmac/mediadocs/bio_Jim_MJ_Delligatti.pdf, downloaded July 15, 2013 and The Economist Big Mac® Index, as reported in http://www.thebraiser.com/the-economists-big-mac-index-2012/, downloaded July 15, 2013.



LESSON 17 INFLATION

4. Ask students to calculate the percentage increase in the price of a McDonald’s Big Mac® from 1967 to 2012.

Percent increase = {[P(year 2) – P(year 1)]/ P(year 1)} × 100 = 862%.

5. Show Slides 17.4 and 17.5 to review answers.

6. Use this opportunity to introduce pur-chasing power with Slide 17.6. Remind students that the percent increase in Big Mac® prices means that consumer income must increase by at least 862 percent for consumers to be as well off (as far as Big Macs® are concerned) as in 1967. Point out that the purchasing power of $1 has decreased in the past 35 years. Ask: How many Big Macs® could you buy for $1 in 1967?

2.22

Ask: How many Big Macs® could $1 buy in 2012?

0.23

In other words, the same dollar that bought a little more than two Big Macs® in 1967 bought less than a quarter of a Big Mac® in 2012.

7. Ask students whether, despite this change in purchasing power, they believe their grandparents really were better off in their time.

Answers will vary, but direct answers toward it depending on other factors—such as what their grandparents’ income was in 1967 as well as whether their grandparents bought more movies or Big Macs®.

8. Have students complete Activity 17.1 up -

tions 1 and 2.

(1) Item with the largest percent increase in price is the Big Mac®. (2) A 500 percent increase means that in order to purchase the same good in 2012, you would need additional dollars equal to five times as many dollars as you needed in 1967.

9. Were consumers much better off in 1967 when Big Macs® cost 45 cents and movie tickets cost $1.22?

One thing you might need to know is the rate at which all prices were rising during these 35 years. If Big Mac® and movie ticket prices rose more quickly than all other prices, these things were a much better deal for the grandpar-ents. To answer the question, we must adjust for the overall rise in prices over time— inflation.

10. Ask students to set aside the rest of Activity 17.1 until later in the lesson.

11. Show Slide 17.7 and introduce the defini-tion of inflation. Remind students what they learned about movie tickets and Big Macs®.

Prices rose over the past 35 years.

When the overall price level increases over time, it is called inflation.

12. Distribute Activity 17.2 and show Slides 17.8 and 17.9, which explain the U.S. Consumer Price Index (CPI). Have students read the section “What is the CPI?” Explain to students that the CPI market basket is like the shopping cart you use at the supermarket; you tend to buy the same kinds of goods over and over. It is the prices of these goods and services that the U.S. Bureau of Labor Statistics (BLS) uses to estimate the change in all prices.



INFLATION LESSON 17

13. Have students read “Working with the CPI” in Activity 17.2. Review the use of an index on Slide 17.10.

14. Have students read “Calculating the Inflation Rate.” Show Slide 17.11, which defines the inflation rate as the percent change in the CPI over a set period. Project a blank Table 17.2-A (or use Slide 17.12) and complete the calculations for the 1995 inflation rate with students. Ask them to complete Table 17.2-A in Activity 17.2 and answer the two questions.

15. Review the calculations with students using Slide 17.13. Ask: What was the impact of an inflation rate of 3.4 percent for 2005 on consumers?

This rate means a 3.4 percent increase in all prices. Student should also ad-dress purchasing power: Average prices increased by 3.4 percent, meaning the same dollar buys 3.4 percent less goods and services in 2005 than it did in 2004. Students should note the impact on the standard of living. With a decrease in purchasing power, consumers need an equal increase in wages to maintain their standard of living.

16. Go over the two questions following Table 17.2-A:

(1) If you earned $10 an hour in 1994, how much would you have to earn in 1995 for your wage to have the same purchasing power?

You would need to earn $10.28. This is a 2.8 percent increase.

(2) If you saved $100 in 2004, how much interest would you have to earn in order for the savings to have the same purchasing power in 2005?

You would need an interest rate of 3.4 percent—or $3.40 of interest.

17. Ask students to return to Activity 17.1. Tell students that the CPI can be used to adjust prices for inflation so that prices from one year can be compared to other years. Economists use the term real prices to indicate that the price has been adjusted for inflation and expressed as a price in a specified year. Economists use the term nominal prices to refer to unadjusted prices (the prices one sees in the store at the time).

18. Have students complete Table 17.1-B in

(Note: If you do not have Internet access to the Minneapolis FED site—http://www.minneapolisfed.org/community_education/teacher/calc/hist1913.cfm—the CPI for 1967 was 33.4 and 229.6 for 2012.) How many times higher is the CPI in 2012 than the CPI in 1967?

6.87

What does 2012 CPI/1967 CPI equal?

6.87

19. Show Slides 17.14 and 17.15 and review the results of the calculations. Ask stu-dents once more: Were your grandpar-ents better off when they paid 45 cents for a Big Mac® and $1.22 for a movie ticket in 1967? Discuss the movie ticket results with students.

In 1967, the “real” price of a movie ticket was $8.39 in 2012 dollars adjusted for inflation, compared to the nominal price in 2012 of $7.92.

Ask: Did your grandparents have cheaper movies?

No, adjusted for inflation, movie tickets are cheaper today.

Discuss the Big Mac® results with students.

In 1967, the “real” price of a Big Mac® was $3.09 in 2012 dollars, adjusted for



LESSON 17 INFLATION

inflation, compared to the nominal price in 2012 of $4.33.

Ask: Did your grandparents have cheaper Big Macs®?

Yes, adjusted for inflation, Big Macs® were cheaper in 1967.

20. Show Slide 17.16 and ask: What has happened to the CPI over time?

In general, it has steadily increased.

Show Slide 17.17. Remind students of the definition of inflation. Tell students that when inflation is anticipated, the impact can be relatively minimal, be-cause consumers and producers can plan for its effects—but when inflation is not anticipated, it creates winners and losers.

21. Distribute Activity 17.3. Have students read the first three paragraphs.

22. Tell students that unanticipated inflation can hurt many Americans financially due to two related factors: decreased purchasing power combined with wages or income that does not keep up with inflation. Tell students an increase in the inflation rate means that consumers’ purchasing power decreases—it takes more dollars to buy the same goods and services. Without an offsetting increase in wages, most consumers are worse off. They experi-ence a lower standard of living.

23. Tell students that to decide if someone in the economy is helped or hurt by infla-tion, they need to determine if their pur-chasing power is increased or decreased. Ask students to read the rest of Activity 17.3. Answer any questions, using Slide 17.18. With students in groups of four, distribute one set of the cut Scenarios slips to each group. Give students a few minutes to complete the task. Ask them to be prepared to defend their decisions.

24. Once students have completed Activity 17.3, discuss answers and show Slides 17.19 and 17.20.

CLOSURE25. Ask: Were your grandparents right in

stating that prices were much lower when they were young?

Yes, average prices rise continually.

26. Ask the following questions on inflation:

a. What do we call this tendency for overall price levels to rise?

Inflation

b. How do we measure this overall rise in prices?

Use the Consumer Price Index to cal-culate the inflation rate.

c. What does an inflation rate of four percent for a given year mean?

Goods and services cost, on aver-age, four percent more than the previous year.

d. What are some economic conse-quences of this?

Purchasing power decreases and consumers can buy less of goods and services; standard of living decreases if incomes do not rise at the same rate.

e. Who are likely to be losers when unexpectedly high inflation occurs?

Those on fixed incomes or with fixed wages, savers with fixed interest rates, and lenders

f. Who are likely to be winners?

Borrowers, especially those with fixed rates, and businesses with long-term leases



INFLATION LESSON 17

ASSESSMENT

Multiple Choice

1. When inflation occurs,

a. prices decrease in the economy.

b. the purchasing power of money decreases in the economy.

c. the dollar appreciates on foreign exchange markets.

d. basic necessities become cheaper.

2. Which of these are likely to be winners in periods of high, unanticipated infla-tion?

a. Savers

b. Lenders

c. Borrowers at fixed interest rates

d. People on fixed incomes

3. Which of these are likely to be losers in periods of high, unanticipated inflation?

a. Minimum wage workers who do not receive raises

b. Households with large mortgages

c. A business that has borrowed from a bank at a fixed rate of interest

d. Businesses that have agreed to pay workers low-COLA wages

Constructed Response

Next weekend, your great-uncle is coming to town, and you know he will tell stories about how things were so much better when he was your age and how things cost so much more today. Use what you have learned about inflation to explain to your uncle that he may not be correct. In your explanation, include the following: inflation, inflation rate, purchasing power, CPI, and who the losers are when inflation increases.

Have students provide one response each.

Answers should include:

Depends . . . you need to compare the rate (inflation rate) at which overall prices increased from the great-uncle’s time to now.

Inflation erodes purchasing power, so yes, it costs more, but you need to adjust for the inflation rate to accu-rately compare prices and incomes in the “good old days” and today. CPI measures overall prices across time.

Some things—such as Big Macs®—cost more in today’s dollars, and some—such as movies—cost less.

Inflation makes winners and losers; workers whose wages do not keep up with inflation and lenders who loaned at low rates of interest are among the losers.



LESSON 17 INFLATION

ACTIVITY 17.1How Much Did Things Cost in the “Good Old Days”?

Have you ever heard your parents or grandparents say, “Back in my day, a loaf of bread only cost a nickel and a gallon of gas only cost a quarter”? How can it be that things were so much cheaper back then? Where they really cheaper? You will try to answer this question by comparing modern prices to historical prices and calculating the percent increase in prices. To do so, you will examine prices of two goods: movie tickets and a McDonald’s Big Mac®.

Calculating Percent Change in Price

Percent change in price is calculated by dividing the amount of change in price by the original price and multiplying the result by 100. If the price has increased, percent change will be positive, and if the price has decreased, the percent change will be negative. The formula for calculating percent change in price:

New price – Old priceOR

Price (Year 2) – Price (Year 1)

Old price Price (Year 1)

Table 17.1-A: Historic Prices

Goods

Price in 1967

(nominal price)

Price in 2012

(nominal price)

Percent Change in

Price

1967 Price in 2012 Dollars

(real price)

Movie ticket $1.22 $7.92

McDonald’s Big Mac® $0.45 $4.33

Complete the last column of Table 17.1-A by using the CPI Calculator at http://www.minneapolisfed.org/index.cfm. Enter the 1967 price, select 2012, and then “calculate.” This price approximates the purchasing power of the 1967 dollar in to-day’s prices—the goods and services that could be purchased for the same amount of money in 2012.

1. Which item had the largest percent increase in price?



INFLATION LESSON 17

ACTIVITY 17.1 (Continued)

2. What does a 500 percent increase in price from 1967 to 2012 mean?

3. Prices seem so low in 1967. Were people much better off then? What else would you need to know to draw a conclusion?

Table 17.1-B: Changes in Overall Price Level

Goods

Nominal Price (1967)

CPI (1967)

Nominal Price (2012)

CPI (2012)

Converting Grandpa’s

Prices: 1967 Price × (2012 CPI/1967 CPI)

Movie ticket $1.22 $7.92

McDonald’s Big Mac® $0.45 $4.33

4. Go to the Minneapolis FED website: http://www.minneapolisfed.org/community_ education/teacher/calc/hist1913.cfm. Find the 1967 CPI and the 2012 CPI. Enter these in Table 17.2-B.



LESSON 17 INFLATION

5. How many times higher is the CPI in 2012 than the CPI in 1967? ________ What does 2012 CPI/1967 CPI equal? _______

6. Use these CPI figures to convert the 1967 nominal prices of movie tickets and Big Macs® into the real prices expressed in terms of 2012 prices.

7. Now that you have converted the 1967 nominal prices into 2012 prices, you can compare prices in your grandfather’s day to the prices you pay today. What con-clusions can you draw about movie ticket prices over the past 35 years?

8. What conclusions can you draw about Big Mac® prices over the past 35 years?



INFLATION LESSON 17

ACTIVITY 17.2The Consumer Price Index (CPI)

What Is the CPI?

The Bureau of Labor Statistics (BLS) collects data on prices across the United States and uses the data to compile the Consumer Price Index (CPI). The CPI is an index that is used to measure the average changes in prices paid by consumers in urban markets for a “market basket” of commonly purchased goods and servic-es. The CPI compares the combined price of the goods and services in the market basket from one month to the next. The BLS collects information about prices of goods and service in eight major categories,* which follow, with examples of goods and services in each:

FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks)

HOUSING (rent of primary residence, owners’ equivalent rent, fuel oil, bedroom furniture)

APPAREL (men’s shirts and sweaters, women’s dresses, jewelry)

TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)

MEDICAL CARE (prescription drugs and medical supplies, physicians’ services, eyeglasses and eye care, hospital services)

RECREATION (televisions, toys, pets and pet products, sports equipment, admissions)

EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories)

OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses)

*Information from Bureau of Labor Statistics, http://stats.bls.gov/cpi/cpifaq.htm



LESSON 17 INFLATION

ACTIVITY 17.2 (Continued)Working with the CPI

The CPI is an index, a mathematical tool that substitutes an index level for the overall price of the market basket. All indices use a base year for easy reference (set to an index level of 100), and the CPI uses the years 1982–84 as its reference base. This means that the average price of all of the goods and services in the market basket for the years 1982, 1983, and 1984 was set equal to 100. The BLS uses this base level to calculate changes in prices of the market basket. An index of 105 for 1985, for example, means there was a five percent increase in the price of the market basket since 1982–84. Changes in the index can be expressed as percent changes, either monthly or annually, called the inflation rate. The infla-tion rate is simply the percent change in the CPI over the reference period. Here is the formula for calculating the inflation rate (Note: Year 1 is the earliest year; for the inflation rate from 1988 to 1990, 1988 is Year 1):

CPI (Year 2) – CPI (Year 1) × 100

CPI (Year 1)

Calculating the Inflation Rate

Using the simple percent change formula above and the annual CPIs in Table 17.2-B, it becomes possible to calculate the inflation rate between any two years. For example, the inflation rate from 1990 to 1991 was 4.2 percent:

CPI (1991) − CPI (1990)× 100 =

(136.2 − 130.7)× 100

CPI (1990) 130.7

= 5.5/130.7 × 100 = 0.420 × 100 = 4.2%

Use the annual CPI data in Table 17.2-B to complete the inflation rate calcula-tions for each year in Table 17.2-A.



INFLATION LESSON 17


Table 17.2-A: Calculating Inflation Rates

CPI (Year 1) CPI (Year 2) Calculations

Inflation Rate from Preceding

Year

1995

2005

2012

1. If you earned $10 an hour in 1994, how much would you have to earn in 1995 for your wage to have the same purchasing power?

2. If you saved $100 in 2004, how much interest would you have to earn in order for the savings to have the same purchasing power in 2005?



LESSON 17 INFLATION


Table 17.2-B: Annual Average CPI (1982–1984 to 2012)

Year Annual Average1982–1984 100.0*

1985 107.61986 109.61987 113.61988 118.31989 124.01990 130.71991 136.21992 140.31993 144.51994 148.21995 152.41996 156.91997 160.51998 163.01999 166.62000 172.22001 177.12002 179.92003 184.02004 188.92005 195.32006 201.62007 207.32008 215.32009 214.52010 218.12011 224.92012 229.6

2013* 233.5*Average CPI for 1982, 1983, and 1984; base level = 100.



INFLATION LESSON 17

ACTIVITY 17.3Unanticipated Inflation: Winners and Losers

Recall the definition of inflation: a long-term rise in the average prices for all goods and services. When inflation is anticipated, consumers and producers can plan for its effects, and the impact can be relatively minimal. When inflation is not anticipated but occurs, it can create both “winners” and “losers”—those who are hurt by unanticipated inflation and those who gain from it.

An unanticipated increase in the rate of inflation hurts many Americans financially. This is mostly due to two related factors. First, an increase in the inflation rate means consumers’ purchasing power decreases—it takes more dol-lars to buy the same goods and services. Second, without an offsetting increase in wages, most consumers are worse off—they experience a lower standard of living.

Economically minded people try to protect their purchasing power. Lenders want to get enough interest on loans they make to increase their purchasing power when the loans are repaid. Savers want to get enough interest on savings to increase the purchasing power of their savings. Workers want raises large enough to increase the purchasing power of their wages.

Unanticipated inflation has different impacts:

LendersGoal: Loan funds at a rate of interest that is higher than inflation. If the inter-est rate charged is higher than the actual inflation rate, the purchasing power of the money repaid to the lender increases. If not, the purchasing power of the money repaid to the lender decreases.

Borrowers Goal: Borrow funds at the lowest-possible interest rate. If the actual inflation rate is higher than the interest rate on the loan, the purchasing power of the borrowed funds the borrower pays back decreases, and borrowers may find it easier to repay their loans (particularly if their wages have increased with inflation).

SaversGoal: Save funds at a rate of interest that is higher than inflation. If the interest rate earned is higher than the actual inflation rate, the purchasing power of the savings increases. If not, the purchasing power of the savings decreases.



LESSON 17 INFLATION


WorkersGoal: Earn wages that increase at a rate that is higher than the inflation rate. If wages increase faster than the actual rate of inflation, the purchasing power of the wages increases. If not, the purchasing power of the wages decreases.

Your group will be given 10 strips of paper, each with a brief description of a fictional person or organization. On January 1, 2013, all of these economic actors anticipated inflation would be 2 percent for 2013—but in 2013, the inflation was actually 10 percent.

Unanticipated Inflation: Winners and Losers

In your group, use your knowledge of the definition of inflation, real prices, and purchasing power to place each slip in the appropriate column: Winner or Loser. If you think that the person or organization described was made worse off over the year by the unanticipated inflation, place your slip in the Loser block; if you believe the person or organization described was made better off in these six months, place the slip in the Winner block. (Note: There are six losers and two winners.) Situation: On January 1, 2013, all of these economic actors anticipated inflation would be two percent for 2013—but in 2013, the inflation was actually 10 percent.



INFLATION LESSON 17


Losers

Winners



LESSON 17 INFLATION

ACTIVITY 17.3 (Continued)Suggested Answers

Losers

1. Hourly-wage worker agrees on January 1, 2013, to a three-year union contract at a local factory. A fixed cost-of-living adjustment (COLA) of 2.5 percent per year is built into the contract.

Wage increase is less than inflation, so purchasing power of wages decreases.

3. Working mother of two children who purchased a six-month certificate of deposit (CD) on January 1, 2013, paying 3 percent annually.

Interest rate is less than inflation rates, so purchasing power of savings decreases.

4. Retiree living on Social Security benefits. No cost-of-living adjustment (COLA) is scheduled until December 31, 2013.

COLA comes at the end of the year. During the year, purchasing power decreased.

5. Large local bank that holds many fixed-rate 30-year home mortgage loans at an interest rate of 5 percent.

Interest rate based on expected inflation. Payments will be worth less due to decrease in purchasing power.

7. Teenager whose college fund is in a savings account with an interest rate of 2 percent.

Interest rate is less than inflation rates, so purchasing power of savings decreases.



INFLATION LESSON 17

8. John, who loaned $1,000 to his friend Julie. Julie pays John back $1,050 after one year, as they agreed.

Julie pays John back $1,050 after one year, as they agreed, but the pay-back has less purchasing power for John due to inflation. Since inflation turned out to be 10 percent, John would have needed Julie to pay him back $1,100 to have the same purchasing power as when he made the loan.

Winners

2. Homeowner with a 30-year fixed-rate (5 percent) mortgage.

Because the fixed rate is lower than the rate of inflation, the money the homeowner repays has much less purchasing power. When inflation was expected to be 2 percent, the bank expected the 5 percent interest rate would mean the homeowner would be paying back enough money so that the bank would be compensated for inflation (2 percent) plus an extra 3 percent as the reward for the bank for loaning the money. When inflation was 10 percent, this resulted in the bank losing purchasing power since the 5 percent interest rate does not compensate for the 10 percent inflation rate.

6. Small business that signed a three-year fixed-rate lease on office space.

Although the nominal price remains the same for three years, because the inflation rate has eroded purchasing power, the “real” rent payment has less purchasing power than the landlord anticipated. The small-business owner benefits.




LESSON 17 INFLATION

ACTIVITY 17.4

Winner and Loser Scenarios

1. Hourly-wage worker agrees on January 1, 2013, to a three-year union contract at a local factory. A fixed cost-of-living adjustment (COLA) of 2.5 percent per year is built into the contract.

2. Homeowner with a 30-year fixed-rate (5 percent) mortgage.

3. Working mother of two children who purchased a six-month certificate of deposit (CD) on January 1, 2013, paying 3 percent annually.

4. Retiree living on Social Security benefits. No cost-of-living adjustment (COLA) is scheduled until December 31, 2013.

5. Large local bank that holds many fixed-rate 30-year home mortgages at an interest rate of 5 percent.

6. Small business that signed a three-year fixed-rate lease on office space.

7. Teenager whose college fund is in a savings account with an interest rate of 2 percent.

8. John, who loaned $1,000 to his friend Julie. Julie pays John back $1,050 after one year, as they agreed.


l esson 17 inflation · inflation lesson 17 13. have students read “working with the cpi” in...

Documents